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Investing for income

By: PETER FISHER

[email protected]

Peter Fisher is Financial Consultant with Blacktower Financial Management (International) Ltd.

WHAT DO investors require when investing for income? The answer may seem self-explanatory but a number of decisions need to be made for the planning to be effective.

Income and a reasonable degree of security are the main priorities for a large majority of investors as they near or reach retirement. At this stage in life, it makes sense to look for lower-risk, high-yielding investments rather than ones that are low-yield with a higher risk.

To some investors, this may involve a whole new mindset following years of investing for capital growth. With over 30 per cent of the over 50’s no longer in full time work, many investors also find that this situation arrives earlier than planned.

Level of risk

When investing for income, the first decision to be made is on how much risk you are prepared to take. Each individual will have their own risk level which needs to be fully understood prior to making any investment decisions.

At the same time, investors need to decide what their income requirements are as well. This could lead to some confusion and concern if they have to take more risk than they desire to meet the income they require.

In deciding the risk v reward balance, this will generally require seeking professional advice as it is a complex field with many investment options all with different risk profiles.

Inflation

Many very cautious investors see cash deposits as the ideal investment for them, especially when rates have been in excess of six per cent gross. However, this type of investment is not without risks. If we believe what the politicians tell us, inflation in the Eurozone is still low. Even at current levels this will have a corrosive effect on the value of savings.

Assuming you have 100,000 pounds sterling in a deposit account, withdraw the interest to live off and inflation averages 2.5 per cent over 10 years the ‘real value’ or buying power of the initial capital will have reduced to 77,600 pounds sterling!

In addition, the income will not keep pace with inflation. Even if you earn a competitive six per cent gross on the savings throughout this time, which is very unlikely, in real terms it will reduce from 6,000 pounds sterling to 4,656 over this same period.

Once investors start to take an income from their investments, preserving the capital value becomes extremely important. This is why, historically, equities make better long-term investments than cash and bonds as they can provide the opportunity for both a rising income and capital growth.

Life expectancy

According to the Office of National Statistics, a 65-year-old man is expected to live for another 16.9 years and women nearly 20. This makes retirees long term investors although many adopt short-term solutions to their income needs. Again, the longer you live the more effect inflation has on your income and capital.

Exchange risks

Those people who moved to Portugal and Spain when one pound sterling bought 1.50 euros, are now suffering badly due to the current exchange rate of about 1.25 euros, assuming that their investment is held in sterling. This alone has resulted in a 16 per cent drop in income without accounting for inflation.

Therefore, expatriates should also consider exchange rate risk and consider investing a proportion of their capital in euros.

Tax situation

Prior to making investment decisions, the individual investor’s tax position also needs to be fully considered. Depending on their country of taxation, different rules and benefits may apply which all need to be taken into account prior to making any investment decision.

Investment options

So, taking all the above into account, what should investors do when planning to provide income? Regardless of whether the bulk of their investment is currently held in cash, a personal pension or a QROPS, they need to consider the following.

There are four main asset classes: Deposit Based Savings, Corporate Bonds and Government Bonds (gilts), Property and Shares or Equities.

Each of the four main asset classes can provide investors with income.  Before deciding what proportion of a portfolio is invested in each, investors need to understand the risk, and pros and cons of the different options and what role each can play within their overall investment strategy.

The length of this article is insufficient to cover these factors and opportunities within the asset classes are continually changing. It is therefore essential that you discuss your needs and attitude to risk with your financial adviser to ensure that a suitable portfolio can be built.

The importance of re-investing income  

It is extremely important that income, including share dividends, rent from property regardless of commercial or private, interest on cash deposits and bond income, is reinvested.

The following table produced by Barclays Equity Gilt Study in 2007 shows the importance of this. While investors are not taking a 100 year view,= they should bear in mind that even with a 10 or 20 year view they need to look long term and be prepared for different assets having short-term setbacks. This is why investors are always cautioned about putting all their eggs in one basket.

Today’s value of £100 invested in 1899

The value of investments and any income they produce can fall as well as rise and past performance is not an indicator of future performance.  Investors may therefore get back less than invested and should be aware of this risk before investing.

Please contact Peter Fisher of Blacktower Group for further information. Call 289 355 685 or email [email protected]